Maryland Taxpayers May Be Due County Income Tax Credits, Supreme Court Rules

Author: Alice Gilman

May 27, 2015

The US Supreme Court has ruled, in Comptroller of the Treasury of Maryland v. Wynne, that Maryland's income tax system, under which residents who pay taxes to another jurisdiction are entitled to credit those taxes against their state income taxes, but not their county income taxes, violates provisions of the US Constitution's Commerce Clause. As a result, a Maryland couple who paid income taxes to other states may be entitled to credit those taxes against their county income taxes, as well as their state income taxes.

Maryland's income tax consists of two parts: state income taxes, which are set at graduated rates, and county income taxes, which are set at rates that vary by county but capped at 3.2%. Despite the "state" and "county" nature of these two taxes, both are considered state income taxes and are collected by Maryland's Comptroller of the Treasury.

Maryland residents who pay income taxes to another jurisdiction are allowed to credit those taxes against the state portion of the tax, but not the county portion of the tax. As a result, part of the income that a Maryland resident earns outside the state may be taxed twice.

Maryland also taxes nonresidents' income. Similar to residents' taxes, this tax has two parts: Nonresidents pay state income taxes on all the income earned within the state; nonresidents not subject to a county tax pay a special nonresident tax. This special nonresident tax equals the lowest county income tax rate set by any county.

In 2006, a married couple residing in Maryland earned income in 39 states. They reported that income and the associated taxes on their 2006 Maryland income tax return. They also claimed a state and county income tax credit for the taxes paid to those states.

The Maryland Comptroller of the Treasury denied their claim for a county tax credit and assessed a tax deficiency. The deficiency ruling was upheld by the Hearings and Appeals Section of the Comptroller's Offices and by the Maryland Tax Court. The Circuit Court for Howard County reversed on the ground that Maryland's tax system violated the Constitution's Commerce Clause. The Court of Appeals of Maryland affirmed that lower court ruling. An appeal to the Supreme Court ensued.

The Supreme Court affirmed the decision of the Maryland appeals court, ruling that Maryland's income tax structure violated the Commerce Clause because it unconstitutionally discriminated against interstate commerce.

Relying on other tax cases that have arisen under the Commerce Clause, the Supreme Court said that a state cannot discriminate between transactions on the basis of some interstate element. States, for example, cannot tax interstate transactions more heavily than transactions occurring entirely within one state. Nor can a state impose a tax that discriminates against interstate commerce by providing a direct commercial advantage to local businesses (e.g., by levying taxes at a lower rate), or by subjecting interstate businesses to the burden of multiple taxation, which is the case if a credit against county taxes is not available. If every state adopted Maryland's tax structure, the Court said, interstate commerce would be taxed at a higher rate than in-state commerce.

The Supreme Court concluded that one way Maryland could remedy this flaw in its tax structure would be to offer residents a credit against county income taxes paid to other states.

Employer Impact

The impact of Wynne on employers is yet to be fully determined. The case does not immediately affect income tax withholding under Maryland's income tax laws. Although the Maryland legislature could eventually tinker with employers' withholding obligations, it has not yet done so.

In response to this decision the Maryland legislature has passed H.B. 72, which would allow residents a county income tax credit against income taxes paid to other states. It is not clear at this time whether H.B. 72 will become law.

However, this case may impact other local income tax regimes - notably New York City and Philadelphia. An employer located in one of these municipalities should be aware that state legislatures may amend these laws to allow residents a local tax credit.

Finally, an employer that reimburses an employee who travels to another state on a short-term basis and who incurs local income tax liability while working in that state should consider the availability of any local tax credits on the amount of its reimbursement.